What are Some Business Fraud Examples?

The news regularly has examples of corporate fraud – Wirecard defrauded the public by €1.9B, Matel defrauded of $3M by hackers, Fiat Chrysler salespeople orchestrated $8.7M in wire fraud. Business fraud is, unfortunately, everywhere. We hear about big corporate fraud all the time, but fraud is actually most common in small businesses. As a forensic accountant, I am often called into a “failing” business only to discover an employee is stealing all the profits! And most of the time the fraudster is the accountant or bookkeeper whom you trusted to implement internal controls!

The best way to avoid losing money to fraudulent activity is to know how scammers steal money and implement preventative measures. In this article, I will discuss ways to mitigate the most common types of frauds in small business:

• AP and supplier fraud
• Timecard and wage fraud
• Property theft
• Phone and phishing schemes
• Credit card and expense report fraud
• Commission fraud
• Embezzlement and other advance accounting frauds

AP Fraud and Fake Supplier Fraud

How many suppliers does your business have? Dozens? Hundreds? If you are a manufacturer, you may even have thousands. When your business becomes too large to monitor 100% of the vendor payments, your accounting department could commit AP fraud. Here’s an example:

Janet is a bookkeeper for Acme Inc., a contract manufacturer. She spends all day entering bills into the system and earns $15/hr. Poor Janet sees herself as the backbone of a $10M supplier base but makes almost no money. What harm is it to slip in a $500 “freight” invoice to a new supplier who happens to share an address with Janet’s boyfriend? No one will notice that missing cash flow. And once the first one goes by unnoticed, why not pay those “freight” fees every month?

Janet is stealing cash through fake supplier fraud. Fake supplier fraud is the most common fraud cases in accounting departments since most small businesses do not have proper AP controls. She may get away with this for years before getting caught (if ever!)

To avoid these employee fraud schemes, you must have an established AP controls policy in place, such as a three-way match, spending approval limits, and three-level approvals. 

Timecard Fraud and Ghost Employee Schemes

Timecard fraud involves clocking in but not actually working. Most are familiar with these types of payroll fraud (perhaps you did this at your first job working fast food?) Examples of timecard fraud include:

• Employees entering timecard corrections to say they “erroneously” clocked out early, when in fact they went home.
• Employees taking vacation without submitting paid time off request.
• Having one employee clock in/out to cover another employee’s absence.
• Employees colluding with the bookkeeper to increase their payroll hours above what was actually worked.

More serious is the Ghost Employee Scheme, where the bookkeeper creates fake employees in the system and issues payroll to that person (who is often a family member or friend.) 

Payroll controls manage the risk payroll fraud schemes. Proper payroll accounting system includes: 

• Submitting hours to managers for approval.
• Requiring dual approval for creating new employees.
• Background checks for new employees.
• Routine payroll audits.

Property Theft

I once worked at a machine shop where the maintenance tech was stealing one bucket of scrap titanium per week to sell to recyclers. Although $80/week is not a lot of money to a business, we fired that employee because his actions promoted a culture of theft – a slippery slope to worse offenses. With over $5M in inventory on the premise, the temptation for employee theft was too great to have anything less than a zero-tolerance policy. 

What company assets can your employees steal? Maybe it is computers or merchandise or raw materials. The easier it is to re-sell, the more likely it is to be a target for theft.

Property theft is mitigated by the following policies:

• Routine inventory counts and reviews, such as cycle counting
• Physical security such as locked doors, cameras, badge readers and visitor management systems
• Zero tolerance for theft

Unemployment fraud

Thanks to Covid-19, unemployment fraud schemes are reaching massive new popularity. In this scheme, a person claims they were laid off from your company when in fact they never worked there (or, at best, were fired for cause.) 

All unemployment claims are sent to you in writing by the state. You should review these claims, verify the information, and report any discrepancies to the state ASAP. This will alleviate you of any potential liability or increase in SUTA/FUTA rates.

Phone scams/phishing

Imagine your employee is working late in the office one evening and receives a call from the main line.

CALLER: Hi, this is Ken with ABC office supply. We received a signal from your printer saying the toner is low, can you please check the machine and report its levels to us?

EMPLOYEE: Uh, I’m the ops manager, I don’t really know how to do that. Our admin usually manages the printer.

CALLER: I can walk you through it, just go to the machine, click settings, and read me the code under toner status and machine serial number.

EMPLOYEE: ok, it says it’s 1/3rd full. Serial Number 274-5675-138-D

CALLER: Ok, it’s time to get a refill. I’m going to ship you a box of refill toner. Ok?

EMPLOYEE: Uh, sure, sounds good.

A pallet of toner shows up at your office with a bill for 10x market price. The vendor claims they have a “verbal PO” from your ops manager and will sue if you do not pay.

The toner scam is a classic type of external fraud, and there are examples of fraud selling everything from post-it notes to cleaning supplies. Worse than the scam itself is when the embarrassed ops manager attempts to cover up the mistake rather than alert the Controller or CEO of the scam. This is a major red flag and constitutes cause for discipline up to and including dismissal.

We recommend educating your office staff about fraudsters and fraud schemes annually, including phone scams and IT scams like phishing. Detecting fraudulent behavior is your first line of defense against external fraudsters.

Credit card and expense reporting fraud

Credit card fraud is the most common employee fraud in small businesses. In this scheme, an employee pays for something with a company credit card (or reports a reimbursable expense) which was actually purchased for the employee’s benefit, not the company’s. This employee fraud commonly occurs with Amazon.com (where purchase details are not on the credit card statement), restaurant meals charged for business development, or fake travel which never actually occurred. 

Many business owners abuse credit cards for personal expenses, telling themselves these fraudulent activities help lower taxes. Or they commit asset misappropriation by using company vehicles or property for personal use. Despite the benefits of owners exercising this privilege, we discourage owner asset misappropriation because:

1. You lower your business value when selling the company.
2. Mixing personal and business expenses pierces the corporate veil, opening up the owner’s personal liability.
3. Tax enforcement is on the rise, increasing the risk of an audit finding.
4. You set a bad example for employees, encouraging a culture of employee fraud.

Credit card and expense fraud prevention is managed through accounting checks and balances: spending limits, routine audits, and purchasing controls.

Commission fraud

Imagine this: it is the end of the month, and your salesperson has been working a big deal for months. The prospect has verbally agreed to the deal, but the paperwork has not yet been signed and returned.

“Let’s count the sale for this month. The paperwork will be in tomorrow, it’s a done deal!” Your salesperson argues.

Commission fraud is one of the most common types of employee fraud. The salesperson is not trying to rip-off the organization (as they genuinely expect the deal to close) but they are cheating the business cash flow. What happens next month if the prospect still has not returned the paperwork?

Another common employee fraud involves recognizing revenue for products that have almost shipped, or for services that have not quite yet been performed. This is often done to hit quota or make a year-end bonus. Unfortunately, owners or managers changing revenue recognition policies for their benefit are committing fraud by skewing financial statements.

Embezzlement through Inventory Fraud

Inventory is a complex account with lots of ins and outs, and thus an easy place to bury embezzlement. Here’s an example:

• Your bookkeeper pays themselves through AP fraud (explained above.)
• They create a journal entry moving the debit from an expense account (like freight expense) to an inventory account (like work in process or finished goods.)
• If inventory is never audited, this employee fraud will go undetected.
• Even with cycle counting, the error will merely be reported as a variance without explanation.

Embezzlement through inventory is one of the most sophisticated types of fraud and is rarely detected in small businesses. To avoid this form of embezzlement, make sure you are following the following steps:

1. Perform inventory cycle counting monthly by someone in operations, not your bookkeeper.
2. Report cycle count variances to managers both within and outside of accounting.
3. Perform routine inventory ledger audits to look for suspicious journal entries.
4. Hire outside accountants to occasionally verify your controller’s work.

What to do if you suspect fraud in your small business.

If you suspect there is fraudulent activity in your business, you need to hire a forensic accountant to properly examine accounting records, document fraud, and deal with the offender. Remember, fraud detection is not part of a financial statement audit, review or CPA tax services, and most accounting firms are not trained in fraud detection. Fraud is illegal making it a potential criminal matter – proper discipline, prosecution, and/or recovery of lost money is dependent on you handling the situation appropriately. Book an appointment with one of our forensic accountants now to discuss your situation and how to avoid fraud moving forward.